Graphical models for correlated defaults
A simple graphical model for correlated defaults is proposed, with explicit formulas for the loss distribution. Algebraic geometry techniques are employed to show that this model is well posed for default dependence: it represents any given marginal distribution for single firms and pairwise correlation matrix. These techniques also provide a calibration algorithm based on maximum likelihood estimation. Finally, the model is compared with standard normal copula model in terms of tails of the loss distribution and implied correlation smile.
References listed on IDEAS
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- Giesecke, Kay & Weber, Stefan, 2006. "Credit contagion and aggregate losses," Journal of Economic Dynamics and Control, Elsevier, vol. 30(5), pages 741-767, May.
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in: Financial Derivatives Pricing Selected Works of Robert Jarrow, chapter 20, pages 481-515
World Scientific Publishing Co. Pte. Ltd..
- Robert A. Jarrow, 2001. "Counterparty Risk and the Pricing of Defaultable Securities," Journal of Finance, American Finance Association, vol. 56(5), pages 1765-1799, October.
- Yu, Fan, 2005. "Accounting transparency and the term structure of credit spreads," Journal of Financial Economics, Elsevier, vol. 75(1), pages 53-84, January.
- M. Davis & V. Lo, 2001. "Infectious defaults," Quantitative Finance, Taylor & Francis Journals, vol. 1(4), pages 382-387.
- Jeffery D Amato & Jacob Gyntelberg, 2005. "CDS index tranches and the pricing of credit risk correlations," BIS Quarterly Review, Bank for International Settlements, March.
- Stefan Weber & Kay Giesecke, 2003. "Credit Contagion and Aggregate Losses," Computing in Economics and Finance 2003 246, Society for Computational Economics. Full references (including those not matched with items on IDEAS)
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